North Sea oil needs to cut costs to survive oil price slump

Offshore industry in the North East faces challenges from global price slump, but savings target also presents opportunities

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An oil rig in the North Sea

While the recent oil price rebound is sparking life in some provinces, the North Sea industry is looking to cut costs by 40% to become globally competitive, as Peter McCusker reports.

Last year’s dramatic oil price collapse led to worldwide job losses, project cancellations and the redrafting of contracts as oil companies slashed spending.

With the oil price rebounding from $40 a barrel to the mid-$60s in recent months there are signs of renewed life in some provinces (see panel) - but not in the North Sea where operating costs at $40 a barrel are the highest in the world.

Last year the accepted cost reduction figure for the North Sea offshore industry was 20% but Oil & Gas UK say this needs to rise to 30% to 40% to secure the basin’s long-term future.

Oonagh Werngren, Oil & Gas UK’s operations director, summed up the magnitude of the challenge at an industry event in London last week.

She said: “Although tough decisions on resources and projects are having to be taken by individual companies, there is also now a concerted effort to work together to tackle the fundamental behaviours that have driven cost escalation on the UKCS (United Kingdom Continental Shelf).

“The goal is to achieve a more internationally competitive oil and gas province and attract the fresh investment needed to unlock the North Sea’s remaining potential. Achieving this will require a 40% reduction in the industry’s cost base.”

An estimated 1,500 jobs have been lost in the North Sea offshore hub of Aberdeen and the oil price collapse has been felt in the North East with the slump from $115 last June taking out drilling firm Archer in Blyth, with the loss of 70 jobs.

Subsea contracting companies to suffer in the region include Deep Ocean and Reef Subsea, both of Teesside, while subsea technology companies Bel Valves and GE Oil and Gas (Wellstream), both of Newcastle, and have cut 50 jobs from their combined workforces of almost 2,000.

Andy Buchanan/PA Wire

An oil rig in the North Sea

The Government has acknowledged the industry’s problems slashing Corporation Tax in March’s Budget and creating a new regulator, the Oil and Gas Authority, to help achieve efficiency improvements.

North Sea costs had risen by 50% in the three years up to June 2014. This was partly due the shortage of skilled staff but more pertinently the difficult technical nature of recovering reserves from a basin where most of the easy to get oil and gas has been secured.

Moves to address staff productivity are already under way, with offshore workers balloting for strike action on efforts to change their shift patterns to three weeks on, three weeks off.

But the key cost-cutting mantra now emerging is ‘standardisation and simplification’.

Ken Cruickshank, Oil & Gas UK’s operations manager told Journal Energy: “One of the key ways the supply chain can contribute to pan-industry initiatives aimed at removing unnecessary costs from the basin is to work with operators, major contractors and small to medium enterprises to simplify and standardise processes including equipment procurement, technical standard setting and manufacturing of components.

“This would help to reduce unit costs in design and maintenance and address the expensive ‘gold plating’ approach which characterised some of the more ‘bespoke’ contracts of the past.”

These cost reduction efforts are providing opportunities for innovative supply chain companies – such as those in the North East.

Mr Cruickshank continued said: “Over the past 50 years of oil and gas production, companies in the North East of England have helped establish the region as one of the UK’s key energy hubs.

“Building on its traditional strengths in heavy industry including fabrication, the North East supply chain has developed a broad diversity of capabilities including health and safety training, asset integrity consultancy and a variety of specialist technical services.

“This industrial expertise will also enable North East companies to play an important role in helping our collective efforts to tackle cost escalation and improve efficiency.”

George Rafferty, Chief Executive of NOF Energy, the business development organisation for oil, gas, nuclear and offshore renewables sectors

George Rafferty, chief executive of Durham-based NOF Energy, believes the role of the North East supply chain in the coming months will be ‘integral’.

In response to these challenges NOF Energy has launched a ‘Smarter Supply Chains’ initiative designed to bring the supply chain closer and create open discussion forums to share ideas about working together more effectively in the future.

One workshop has already taken place with MOL Energy UK and two more are planned in the autumn with oil companies Apache and Maersk.

Mr Rafferty said: “The industry is looking to companies that can meet its efficiency demands through the creation of disruptive and innovative technologies and services. The North East supply chain is an exemplar of a talented and resourceful group of businesses that are continually innovating to deliver the efficiencies, as well as support increased productivity.

“The challenge is to increase the collaboration and partnerships between operators and lead contractors with the supply chain. As the industry consistently develops its supply chain relationships it’s vital that companies are able to engage with potential customers to support the creation of beneficial solutions.

“NOF Energy is working closely with our members and our operator and contractor partners to create a strong and collaborative landscape for the industry that will enable the UK oil and gas sector to meet its efficiency targets while maximising the recovery of resources.”

The oil and gas sector is looking to learn from production practices in other successful UK industries such as aerospace and automotives.

At the end of next month Oil & Gas UK and the Chartered Institute of Procurement and Supply will hold a seminar looking at the simplification and standardisation initiatives.

This will see speakers from the automotive and aerospace including Lockheed Martin, Siemens and partners, Renault Nissan and Bombardier share with delegates how improvements in supply chain practices could help the oil industry to achieve significant long term business benefits.

Mr Cruickshank said: “A huge amount of co-operative work is taking place throughout the sector but there is significant scope for improvement. We believe that much can be learnt from experience of other sectors including the process, extractive and engineering industries where a fresh approach has yielded success in cost and efficiency.”

Significant reserves of up to 23bn barrels of oil and gas equivalent remain to be extracted from the UKCS and technological innovation, combined with an emphasis on costs, may help ensure these reserves are secured.

Mr Cruickshank added: “In the current business environment, individual companies have to make tough decisions on resources and projects but bold collective effort now will help lay the foundations for creating a sustainable oil and gas industry for the future.”

Where is the oil price heading?

After plummeting from $115 a barrel in June last year to $40 in March this year the oil price has now recovered to the mid $60s, but the jury is out on where it will head next.

The dramatic fall was a consequence of the Saudi Arabian response to increasing shale oil production from the US, which is now the world’s largest producer of oil and gas.

The Saudis, determined to maintain market share, refused to cut their production and as supply outstripped demand the price fell sharply.

The cost of production in Saudi Arabia at $5 a barrel at least 10 times less than US shale and the Kingdom’s tactics were successful, leading to a 50% fall in the number of US drilling rigs.

However, with shale being a relatively new industry the producers have been able to re-work operating techniques and boost efficiency.

Wells that used to take 35 days to compete now take 17, better seismic data equipment has been developed and fracking liquids improved, research firm IHS now says that 80% of new US capacity will be profitable at a range of $50 to $69, compared to last year’s price of over $80.

Signs are now emerging that the sharp price falls are leading to an increase in demand, especially in China which appears to be boosting reserves before the price rises again.

According to the International Energy Agency, global year on year demand for oil increased by a “surprising” 1.3m barrels of oil equivalent per day (boepd), year on year, in the first quarter of 2015.

The Organisation of the Petroleum Exporting Countries (Opec) predicts the world will need to produce 111m bpd of crude by 2040 to meet world demand - representing another 20m boepd on top of existing output.

Some of this may come from Iran which could export an extra 5m boepd when sanctions are lifted and further supplies will be available if the US lifts its oil export ban

But the great price shock has seen over $100bn of projects cancelled. Many of these have been the more difficult to reach, and expensive targets, in deepwater, ultra-deepwater, tight oil, shale, oil sands, and high pressure high, temperature fields.

Shell is predicting Brent oil prices of $67 a barrel in 2016, rising to $75 a barrel in 2017 and $90 a barrel in 2018-2020 and OPEC is saying oil will not exceed $76 a barrel until the 20202.

However financial firm Goldman Sachs last week said it expected prices to fall in the coming months, saying the current piece is tempting shale players back into the market and this will depress the price.

The long term demand fundamentals look set to push the price higher in time, but few expect it to reach the $100 a barrel for some time and as Goldman Sachs has warned, this oil cycle may be a W-shaped one, rather than a U-shaped one.